Cyprus is 'Systemically Important'

Mario Draghi has woken up from his 'all is good' slumber and admonished the political wing of the eurocracy regarding the mooted bailout of Cyprus. In particular, Draghi has corrected German finance minister Wolfgang Schäuble regarding the view, recently expressed by the latter, that “Cyprus is not systemically important”. It is, says Draghi, and he's probably right about that. A lot of moolah is lying around in its banks after all. In other words, although Cyprus is ostensibly small, it too is “too big to fail”. Color us unsurprised.

“The head of the European Central Bank, Mario Draghi, warned German Finance Minister Wolfgang Schäuble last week not to dismiss Cyprus as not being 'systemically relevant' and said a failure to bail out the island nation could threaten the wider euro zone.

European Central Bank President Mario Draghi confronted German Finance Minister Wolfgang Schäuble last week to criticize his stance on Cyprus and said failure to bail out the island nation could threaten the euro zone.

At a meeting of EU finance ministers last week, Draghi contradicted Schäuble's view that Cyprus was not "systemically relevant," a term that implied it wouldn't endanger the euro zone if it went bankrupt.

Draghi told Schäuble that he often heard that argument from lawyers, even though the question of whether Cyprus was systemically relevant or not was not one that lawyers could answer. That, said Draghi, was a matter for economists. Schäuble is a trained lawyer.”

(emphasis added)

Note the little barb there – “you're a lawyer, what do you know?”. Of course one might well ask what do mainstream economists know? According to them, the world will stop turning if not all and sundry are bailed out, a view that is contradicted by historical experience as well as sound theory.

'Judicial Arguments' and Wobbly Banks

Der Spiegel continues:

Draghi was backed by the European Economic and Monetary Affairs Commissioner Olli Rehn as well as the head of the European Stability Mechanism, Klaus Regling.

The three pointed out to Schäuble that the two biggest banks in Cyprus had a large network of branches in Greece. If any doubt were cast on the safety of deposits held with those banks, the uncertainty of Greek savers could quickly spread to Greek banks, which would represent a major setback for Greece.

In addition, they argued, a Cypriot bankruptcy would undo the positive news that had recently helped to calm the euro crisis.

In recent weeks, all indicators have pointed to an improvement, they said. The risk premiums on Spanish and Italian sovereign bonds had fallen significantly and the liabilities of national central banks had retreated from the dangerous levels they had reached. This recovery could be reversed if Cyprus was refused aid. It would also make it harder for Ireland and Portugal to return to financial markets.

They also came up with a judicial argument for helping Cyprus: the country had contributed to the bailout fund, hence it was entitled to assistance from it.

Aid talks for Cyprus, which has applied for a financial rescue that could reach more than €17 billion ($22.8 billion), have run into difficulties because of concern in Germany and other European nations that the island has become a haven for dirty money from Russia. Cyprus denies allegations that it is a hub for money laundering.”

(emphasis added)

This is too funny – now these economists are making “judicial arguments” as well, right after telling Schäuble the lawyer that he's not qualified to dabble in economics! You couldn't make this up.

What they say about the (just recapitalized for the second time) Greek banking system is quite interesting though. It highlights the fact that the fractionally reserved banking system is at all times only a tiny step away from insolvency, no matter how much money is thrown at it. Perhaps what is needed is a major rethinking of the fractionally reserved system and the central bank that backstops it? Just a thought.

Speaking of the “risk premiums on Spanish and Italian bonds”, Spain's bond yields actually look just about ready to rise again: